Wednesday, February 05, 2014

How the New Classicals drank the Austrians' milkshake

The "Austrian School of Economics" is still a name that is lovingly invoked by goldbugs, Zero Hedgies, Ron Paulians, and various online rightists. But as a program of scholarship it seems mostly dead. There is a group of "Austrians" at George Mason and NYU trying to revive the school by evolving it in the direction of mainstream econ, and then there is the Mises Institute, which contents itself with bathing in the fading glow of the works of the Old Masters. But in the main, "Austrian economics" is an ex-thing.

It seems to me that the Austrian School's demise came not because its ideas were rejected and marginalized, but because most of them were co-opted by mainstream macroeconomics. The "New Classical" research program of Robert Lucas and Ed Prescott shares just enough similarities with the Austrian school to basically steal all their thunder. The main points being:

Ludwig von Mises based his theories on something called the Human Action Axiom, which he states thus:

Human action is purposeful behavior. Or we may say: Action is will put into operation and transformed into an agency, is aiming at ends and goals, is the ego's meaningful response to stimuli and to the conditions of its environment, is a person's conscious adjustment to the state of the universe that determines his life.

Like all of Mises, this is written in the dense, pre-WW2 European literary style, and thus probably never had a chance of appealing to plain-spoken American academics. But the basic idea here seems twofold. First, the "ends and goals" thing seems very similar to modern economists' notions of individual rationality - an idea that is, of course, at the center of New Classical macro (and most other mainstream economics).

More significantly, the "conscious adjustment" part sounds like a less clearly stated version of Rational Expectations. This is basically the idea that human beings are as smart as the economist who is trying to model their behavior. If you conclude that the economy works a certain way, then the agents in your model should reach the same conclusion. Behavioral models that rely on robotic, predictable human behavior will inevitably fail.

A corollary of this is that we have to be very careful of government policies that try to manipulate people's behavior. People are smart, the theory goes, and they will catch on to your trick and find a way to work around it. This is part of the motivation for the Lucas Critique.

2. Praxeology vs. "Theory Ahead of Measurement"

Mises thought that the best way to study economic behavior was not to make empirical observations, but to deduce what rational, self-interested humans would do in a given situation. He called this approach "praxeology". Austrians who follow Mises tend to pooh-pooh empirical studies and assert the primacy of pure logic in predicting human behavior.

New Classical macro doesn't go nearly this far, but it has some of the same flavor. The Lucas Critique showed how econometric studies would often be useless without a structural model to back them up...and the New Classicals strongly preferred structural models that were based on assumptions of full human rationality. In an essay entitled "Theory Ahead of Business Cycle Measurement," Ed Prescott asserted that his Real Business Cycle modeling paradigm was too good to be rejected by econometric studies. On his website, he cleverly admonished macroeconomists to "progress, not regress." When Thomas Sargent did a bunch of econometric tests that rejected a bunch of Rational Expectations-based models, Prescott and Lucas actually went so far as to ask him to stop, telling him that his tests were "rejecting too many good models".

This is far from praxeology, since Prescott and Lucas did not ignore data entirely. But it has the same flavor of weighting a priori plausibility more heavily than other economists might like.

3. Deep suspicion of government intervention

Both the Austrians and the New Classicals were and are deeply suspicious of government intervention in the macroeconomy. Mises and the other original Austrians, of course, strongly disapproved of the interventions favored by Keynes during the Depression. Robert Lucas pooh-poohed the notion of fiscal stimulus in the 2009 recession, though he supported the idea of monetary easing. Ed Prescott went much further, claiming that monetary policy couldn't boost the economy at all.

Austrians and New Classicals share a deep faith in the free market on structural matters as well. Both Lucas and Prescott have blamed America's recent economic weakness on the (allegedly) interventionist policies of the Obama administration.

4. Big difference #1: Formal mathematical modeling

One area where Austrians and New Classicals differ dramatically is regarding the usefulness of formal mathematical modeling of economic behavior. Austrians were (and the purists at the Mises Institute still are) dead set against it. But mathematical modeling is the bread and butter of New Classicals, and in fact is a special mark of pride.

5. Big difference #2: Causes of the business cycle

Austrians generally thought that the business cycle was caused by malinvestment, which in turn they attributed to excessively easy monetary policy. New Classicals, on the other hand, ignored the possibility of malinvestment completely; financial markets and businesses' investment decisions are, in New Classical theories, functioning optimally at all times. The New Classicals believed that business cycles were caused by "real shocks", such as slowdowns in the rate of technological progress, or increases in harmful government intervention. They also feared overly easy monetary policy, but because they thought it would lead to inflation, not malinvestment. (Of course, Austrians feared inflation as well.)

So it basically seems to me that the New Classicals captured and improved on the basic ideas of the Austrians in almost all of the ways that matter, while vastly improving on the presentation. New Classical concepts of rationality, distrust of empiricism, and distrust of government intervention are more moderate and nuanced than those of the Austrians, and their mathematical style is simply much more appealing to modern academics than the dense, turgid prose of von Mises or Hayek. Thus, if you were a smart young macroeconomist in 1980 who believed that people were both rational and smart, that government intervention was a bad idea, and that theory was the best way to investigate human behavior, you did not become an Austrian; you became a New Classical.

In other words, the New Classicals drank the Austrians' milkshake.

The only slight exception is the idea of malinvestment and financial market malfunction, which the New Classicals discarded entirely...but that is unlikely to provide a big enough foundation on which to rebuild the edifice of the Austrian School. I'm pretty confident in saying that the paradigm of von Mises and Hayek is dead.

Updates:

Arnold Kling comments, giving New Classical macro a piece of his mind, and wishing that Austrian ideas had gone in a slightly different direction.

I agree with this. Hayek's big break with general equilibrium modelling came from issues around how knowledge was acquired, not what people do with it once they have it. Rational expectations is addressing the second part, not the first.

Overall, as I understand it, Hayek thought the interesting question was about the journey of the economy, not its destination. New Classicals strike me as the antithesis of that.

Neat post. As someone who was pretty deep into the Austrian stuff, a couple points.

On #1, the human action axiom is not really analogous to REs. All Mises is saying, in a very convoluted way, is that an action by a person is always "rational", where Mises' notion of "rational" is that, when a person does something we have to assume that, from their perspective (whatever info, computational power they have, etc.), it makes sense. It's a very broad notion of "rational" and it doesn't really have anything to do with a person - or agent- understanding the model within which reside. It doesn't even preclude adaptive expectations or, for example, Herbert Simon's notion of 'satisficing'.

I would dispute #5 to a degree. Phelps (1970) and, in particular, the incomplete information model of Lucas (1972), are very similar in a way to Hayek's business cycle theory. The Lucas model shows that when information is incomplete, fluctuations in the money supply can generate disturbances to the real distribution of production because firms don't know whether their new revenue is consequence of changes in relative demand or the new money. Combine this with the time to build model by Kydland and Prescott (1982) and you've got something very similar to the ABC theory.

The Action Axiom (which shouldn't be called an "axiom", gaaahhh) seems like more than just rationality. It also seems like it's saying that people are smart, and therefore can't be modeled like natural phenomena. Maybe I'm giving Mises too much credit here.

Yeah, he's saying actions are not the product of "pure instinct" but he's not saying anything remotely close REs. His claims have nothing to do with the consistency of expectations or how expectations correspond to actual realizations. These are stronger and more detailed notions of rationality than what he's talking about.

The Lucas Islands Model says that when there's incomplete information production responds to changes in the money supply that are not warranted by changes in real demand. Malinvestment is just investment in, or the production of, goods/products that is not warranted by changes in relative demand. The fundamental ideas are very similar.

Mises never uses the term "action axiom" himself, that term was coined by later writers. It is more analogous to the weak axiom of revealed preference than to rational expectations, which adds the counter-factual assumption that people's beliefs always align with economic reality.

...Stronger in the sense of being more restrictive, not in the sense of being (necessarily) better...

Any action is "Mises-rational", because Mises-rationality just means doing what you decide to do to achieve your goals, given whatever information and limitations you have. Just how close this is to 'completeness and transitivity' rationality is an interesting question, but I'd agree that they're pretty close. On the other hand, RE is a much stronger claim about what kind of information you have to make your decisions.

The "conscious adjustment" part just means that acting is adjusting to your environment to try to be happier (richer, etc). I don't think it meant anything about learning and expectations.

Although I prefer the mathematical modeling of mainstream economics, there are a few 'Austrian' ideas that seem interesting to me. First, the storytelling of disequilibrium. As I see it, their business cycle theory is about movements between intertemporal equilibriums. Second, the emphasis on capital structure and intersectoral relations. Third, the effects of monetary policy on relative prices, given this capital structure and possibility of disequilibrium. I'm a kid, so I don't know how much of this has already been modeled mathematically, but I haven't seen much of it yet. Haywin's interpretation of those papers is almost the first I've heard of it.

Rational Expectations is just a less mushy, formally-modeled version of Mises-rationality. That Mises-rationality is all-encompassing of human action, but is too "deep" to be "narrowly vulgarized" by mathematics tells one all they need to know.

But you're absolutely right that the Austrians asked and do ask all of the right questions. It's just a matter of attacking those problems empirically to effectively answer them -- something Austrians and New Classicals are allergic to.

Andrei Shleifer has done a bunch of great work on the implementation cycles that occur from longer-run shifts in productivity as a result of major innovations hitting a point of stagnation (think: stagnation in chemicals and auto manufacturing in the 70s that led way to the first major implementations of IT in the 80s.).http://faculty.wcas.northwestern.edu/~lchrist/papers/implementation.pdf

Further, Mark Gertler has done great work on the endogenous technological basis for longer-run periods of robust growth followed by relative stagnation.http://www.nyu.edu/econ/user/gertlerm/medterm.pdf

All of this fundamentally comes down to the question of the Long Wave, which is a problem largely ignored in mainstream macro that Schumpeter was OBSESSED with.http://en.wikipedia.org/wiki/Kondratiev_wave

Although I think the reason mainstream macro rejects the idea of the Long Wave is because it's so amorphous and hard to model as posited by Schumpeter, Hayek, et al. I see the work of Shleifer, Gertler and even Paul Romer (http://en.wikipedia.org/wiki/Endogenous_growth_theory) as backing out an empirical basis for phenomena that Austrians have only ever analyzed on a literary basis. To be fair, Marxists like Ernst Mandel have also theorized the existence of a Long Wave on a level similarly mushy to Schumpeter.

And to make a long post short, that's where I think Austrians/New Classicals/Marxists fundamentally differ from New Keynesians/Market Monetarists. The former is largely a set of conclusions cemented in a priori, deductive assumptions and the latter is largely a set of methods cemented in inductive, empirical analysis of reality.

@Noah: "It also seems like it's saying that people are smart, and therefore can't be modeled like natural phenomena."

No, for Mises people can't be modeled like natural phenomena because they make free choices. They can be completely idiots, for him, and this would still be true. Mises's "rationality" has very little to do with neoclassical "rationality."

My undergraduate institution has a couple Austrian believers/sympathizers, among them a Koch-funded position.

Promising intro to macro and micro students are closely watched and then preyed upon by these sympathizers. Then are befriended, given extra attention, special tutoring/TA positions, and invited to join an exclusive club where not-so-critical readings that ultimately enshrine the works of Hayek take place.

It's absurd, and frustrating to witness at a public institution. It's too bad the department doesn't suggest or support such a club for those not drinking the kool-aid.

It's interesting that you see Austrians as "preying upon" bright students. One could just as easily say that every prof teaching IS/LM was "preying upon" the students. Or you could accept that people have the free will to choose what to believe, and that they will ultimately be convinced by the best argument presented to them.

"Free will to choose what to believe" is a stretch here - it's not as if all views are equally represented, then students make up their own mind. It's not as if the Austrian profs have die hard NK's sitting across from them playing devil's advocate here - it's almost indoctrination, and it's wrong for *either* side to do it.

There are few things more terrifying in an academic setting than a room full of grumpy people who all think the same thing.

Jefftopia, these things happen with all ideologies. When I teach, I try to be scrupulously fair in presenting all minimally respectable points of view. (I.e., I do not present views on how the economy is run by the Freemasons.)

I am disturbed when Austrians to this sort of thing, and when Keynesians do it, and when Marxists do it, Etc.

Your blog hero Brad DeLong told me of a relevant datapoint. When he co-editing at The Journal of Economic Perspectives he learned of an AEA survey about what members wanted in the AER. Members were asked if the Review should publish more, fewer or about the same number of articles in various fields as it had in the past x years. Most said the Review should publish fewer articles on "Neo-Austrian Economics". This would be challenging as the Review had published zero such articles in the past x years.

I disagree with your conclusion. Laypeople care about and understand jobs/economy etc, and this is tied to the business cycle. Austrian Economics appeals to more and more laypeople today (the people you discount at the beginning of your article) because it offers the clearest and most reasonable explanation for the business cycle. Non-austrians are preeminent in politics, academics, and all other leading areas. They have only themselves to look to and blame for the current problems. Their tired solutions (call them keynesian or neo-classical or whatever) are failing. Austrians are waiting in the wings with very different policies based on elegant theories we've held from the beginning.

"Within modern subjectivist economics it has become customary to distinguish several schools. We usually speak of the Austrian and the Anglo-American Schools and the School of Lausanne. Morgenstern’s work,11 which you have before you, has said almost all that is necessary about the fact that these three schools of thought differ only in their mode of expressing the same fundamental idea and that they are divided more by their terminology and by peculiarities of presentation than by the substance of their teachings."

Ha ha, this is nothing compared to what economic historians have experienced. Nobody pays attention to their ideas until they make it through to some formal model that hardly ever credits them. I am finishing up a methodological paper on this that echoes many of the things we have discussed. I was hoping you could have a look at the first draft. Let me know if you are willing. And let's set up a date to meet!

Far from “dead,” the Austrian paradigm is making a comeback in macroeconomics. The financial crisis has put some neglected “Austrian” issues back on the table. 1) The bust may be preceded by an unsustainable boom2) The unsustainable boom is caused by loose money creating “artificially” low interest rates3) The artificially low interest rates of the boom create malinvestment that will have to be corrected once the bust hits and, indeed, will eventually bring on the bust if monetary factors don’t kick in first

Since the crisis hit, these ideas have enjoyed renewed life outside the Austrian school.

Anna Schwartz blamed the crisis in part on expansive monetary policy:http://www.cato.org/sites/cato.org/files/serials/files/cato-journal/2009/1/cj29n1-2.pdf

John Taylor says, “[M]onetary excesses were the main cause of that boom and the resulting bust.” http://www.amazon.com/Getting-Off-Track-Interventions-PUBLICATION/dp/0817949712

Leijonhufvud tells a tale of crisis that is “more Keynesian than Monetarist,” but “more Austrian than Keynesian.” (Cambridge J. of Econ. 33(4)).

I would agree with Roger one point, particularly in regard to the comparison with the New Classicals. The special role of the housing sector and its boom and collapse in the recent problems fits more with the malinvestment theory than with anything the New Classicals have had to offer. Those posing that somehow workers woke up one day and got lazy still are unable to explain why we have all these people who got laid off who are apparently trying to get jobs but failing to do so. I guess those people are lying.

I don't think I understand your reply, Noah. Leijonhufvud invokes the Austrian school explicitly. John Taylor has praised Hayek a lot and got Hoover's Hayek prize in 2012. William White is explicit about drawing on both Hayek and Mises. Plus you have, of course, work being done by self-identified Austrians such as Lawrence H. White, Steven Horwitz, and Andrew Young. So all that life in the corpse is not "accidental replication." I guess you could call it pilfering, but I think folks usually use the word "persuasion" for such things. Pilfering or persuasion apart, the facts just don't seem consistent with the claim that the "paradigm" is dead.

@Jefftopia: "Whenever I'm tempted to buy into the "malinvestment" theory, I think of Minsky's hypothesis, and realize that it's a better version of malinvestment."

Yes, I appreciate Minsky, too, but his ideas don't really contradict Hayek's so much as complement them. This Keynes-Hayek compatibility was also seen by Robertson, Shackle, Lachmann, and most recently Goodspeed.

I keep being bemused by people not understanding the difference between land price bubbles and "housing investment" bubbles. Minsky is talking about financial asset bubbles not real investment bubbles. There is the world of difference!

FWIW: I don't really feel like I've profited from reading Minsky. Forgive me for being tart, but I can't see why it isn't an Anne Elk theory. You know, the Mony Python bit where Anne Elk's theory is that brontosauruses are "skinny at one end, gets fatter as you go to the middle" and so on. We move inevitably from hedge to speculative to ponzi finance without people ever learning the pattern or, to my mind, any very good reason for the pattern ever being given. No conditions in which the march is faster or slower or that might prevent the move into Ponzi finance. Just "stability itself is destabilizing." He more or less puts his finger on something requiring an explanation, but I don't see where he's really given us an explanation.

P.S. My own view is that there are three types of recessions - and trying to build a single model of all of them is difficult. (1. There are normal short, sharp the Central Bank wants to kill inflation by putting on the brakes types of recession, 2. there are the external shock types of recession - usually a terms of trade shock, 3. there are debt overhang types of recession - like the current one where financial assets have been systematically mispriced for a period of time and the realisation of this, usually also brings with it a substantial change in risk premia).

Part of the problem is trying to imagine that all business cycles are same.

I would say that Austrian ideas are experiencing a resurgence for political reasons, not because they have any explanatory power. All the empirical evidence suggests that unregulated financial markets contribute to deep 'boom and bust' cycles, that monetary policy in fact works, and that fiscal policy, when it is politically possible, also works, and 'automatic stabilizers' in particular also work. That suggests that if you think high amplitude cycles are a bad thing for most people, there is a role for government to dampen the cycles. Government requires money, money requires taxes, and in an economy where the majority of citizens make only enough to get by, the incidence of taxes will fall mainly on the well off. Therefore, an economic theory which 'predicts' that government intervention is in fact responsible for all economic misery is very appealing to the elites regardless of the fact that it has no empirical support.

The "too low for too long" story has only revived Austrian economics for political reasons, not economic reasons. It is attractive to anarchists, libertarians, and other seething government haters since the blame solely falls on the Fed.

Then Austrians declare triumph and claim that they were right: The Fed is evil!. We must abolish it and go back on a gold standard or adopt free banking.

What is even more absurd is the Austrian remedy: abolishing the Fed and going back to a gold standard or adopt free banking without any sorts of regulation. The Austrian position on monetary policy is simply absurd.

While one may argue that low interest played a role, they were minor. It was not lax interest rates, but lax regulation. It was not because Greenspan kept interest rates too low, it was due to his blind worship of free markets.

We had a chance to regulate the derivative market, but Greenspan mocked people who advised such things or even ran them out of D.C. Instead, he proclaimed that the only regulation we needed was self-interest. Self-interest and greed would regulate the toxic derivative market.

As for John Taylor, the guy is a quack. He literally believes that Obamacare, Dodd-Frank, and lack of school vouchers is why we are not recovering when all data points to an AD problem. Why anyone takes him seriously is beyond me.

Anonymous, if you want to look at where to point the finger, think about what was causing the Fed to have low interest rates in the first place. The answer is the trade deficit - that consistant enormous leakage of liquidity out of the economy. People need to raise their perspective above the purely national. The INTERNATIONAL financial system is dysfunctional.

"First, economics is all about individuals. That is because economics is all about choice. We can’t have everything, so we have to choose which things are most important to us: would we prefer a new car, for example, or a summer holiday? To go out with friends, or to relax at home? Invariably, we have to give up one thing (an amount of money or time and effort, say) to get another (such as a new pair of shoes or a tidy garden). These are economic decisions – even when no money is involved. They are questions of how we juggle scarce resources (cars, holidays, company, leisure, money, time, effort) to best satisfy our many wants. They are what economics is all about." - Eamonn Butler, Austrian Economics

That entire PDF is worth reading if you're genuinely interested in learning about Austrian economics. It also touches on heterogeneous activity. Heterogeneous activity is obviously the opposite of homogeneous activity. Homogeneous activity is where you tie all the kids together and then send them to go find the Easter Eggs. It's a centralized, top down approach. It's saying "public infrastructure is a SURE investment! We don't need to create a market in the public sector because I know exactly where the Easter Eggs are. I wear a large electric purple turban that makes me omniscient!"

"Because of the coercive nature of government activity, two additional results come forth. First, by voluntarily purchasing an item on the market, an individual demonstrates that he values the item more than the money price. But in paying taxes, he makes no such demonstration. The government does not know, as a business does, the value individuals place on its activity. Since government cannot obtain the information and incentive by demonstrated preferences of individuals, they cannot efficiently serve individuals. " - Jeffrey Herbener, Austrian Methodology: The Preferred Tax Type

Austrians acknowledged that it's a problem that we don't know what the demand is for public goods. You and your electric purple turban wearing posse think otherwise. Please take your turban off. It really doesn't make you omniscient...it just fills you up with hubris.

BTW, Noah: I do think a lot of mainstream ideas came out of the Austrian school. Lucas originally thought he was being very Hayekian, which he was in some ways as you point out. The Austrian element in standard micro is *huge* IMHO.

Please allow me also to say that Mises' stuff on "praxeology" is mostly methodological. He was not saying "Here's how you should do economics. Do it this new way I invented." He was saying, "If you check out economics has always been done, it's really just careful deductive reasoning based on the idea that people are seek goals in an uncertain world that gives them limited time and resources." That is more or less what Robbins (following Mises) said and more or less what J. S. Mill had said. Later Lakatos's "hard core" would be widely accepted, but it seems like nobody sees the similarity things to Mises was saying back in the thirties. To the extent that they differ I personally pick Hayek over Mises, but I think Mises is underappreciated and that his "apriorism" is not well understood by its friends or enemies.

Yeah, I would pick Hayek over Mises as well. Hayek rocked with his partial knowledge. But I really do love Mises' consumer sovereignty...the idea of millions and millions of consumers dollar voting on a daily basis to give more influence to the producers who create the most value with society's limited resources. It stands in stark contrast to the democratic system where people spend a couple of hours a year ballot voting. If the input doesn't accurately reflect the true preferences of citizens...it's a given that the output won't provide citizens with the maximum possible value.

Mike is a crank who is more interested in defending his own turf than seeking truth. A true scholar asks, "What does the Austrian school have to offer that other thinkers don't?" Then, we see some claims are overblown, some are half-true, and some hit the mark. An ideologue, on the other hand, just cherry picks for whatever can "refute" an entire group of people including many of the most renowned economists in the history of the subject. No one should pay any attention to such partisan "history."

Oh lord, accusations of "crank" are priceless coming from an economics school that is regarded by **virtually everyone** (except themselves) as one of the worst schools of cranks around.

" A true scholar asks, "What does the Austrian school have to offer that other thinkers don't?" Then, we see some claims are overblown, some are half-true, and some hit the mark."

Funny you say that as some kind of attack on Mike when Mike links to my post here where I do exactly that.

I even give a positive appraisal of some Austrians like Lachmann and agree that Austrian economics has some correct ideas, such as (1) that money is non-neutral always, (2) that economic agents face degrees of fundamental uncertainty (as well as calculable risk), (3) that rational expectations is rubbish, and (4) that expectations have a fundamental subjectivist element.

Despite that, Austrianism has incredible flaws and its vulgar supporters on the internet are often barely even aware of what their beloved theory even says.

And he somehow overlooks the fact that no matter what position one takes, including his own, one must "refute" an entire group of people including many of the most renowned economists in the history of the subject.

However, I already link to two of Gene's posts at my site, and intend to link to several more. Because they are good criticisms of specific arguments of libertarianism and that's the purpose of my site.

@Lord Keynes: "Oh lord, accusations of "crank" are priceless coming from an economics school that is regarded by **virtually everyone** (except themselves) as one of the worst schools of cranks around."

LK, are you being intentionally dishonest here? Because you know darned well that I am not "coming" from any school of economic thought at all, and you yourself have seen me defend Keynesian ideas against Austrians on many occasions.

That being said:

1) I call Mike a crank because he obsessively and indiscriminately collects every criticism of libertarianism (on a page I surely HAVE seen) without any regard to whether they have any validity.

2) I have attended many major conferences (EEA, AEA) where there were Austrian economists present. NO ONE regarded them as "cranks." That being said, there are Austrian economists who would be so regarded... they just don't attend those conferences.

Isn't it funny that I can cite a scholarly and authoritative debunking of Austrian Economics, but I am "indiscriminate" and a "crank" in the eyes of the author of an introductary Austrian Economics text?

I see Gene has also joined the ranks of libertarian mind readers who can remotely diagnose obsession and survey conference goers by mysterious mental powers alone.

What Gene claims is "indiscriminate" is actually selecting criticisms that are appropriate for multiple audiences: different people have different standards of validity. He'd know that if he had read the page I suggested.

Don't be pompous and puffed-up, Gene. Use the words you really mean, such as "poopeyhead".

In my opinion malinvestment is by far the most important Austrian thesis, and the only reason it still garners interest, unless you count the more basic thesis that value exists only in the mind of the beholder, which Austrians helped spread.

So I consider Minsky the closest modern econ to Austrian. No surprise that nearly all predictors of the 2008 cras were either Austrian or post-Keynesian.

The lack of interest among econ PhD industry seems trivial and unimportant. None of them have a clue about anything in life.

I am interested in where "malinvestment" comes from if people are smarter than economists or governments. Or is it just the case that one has to "keep dancing as long as the music is playing"? Or some sort of "Gresham's Law" in action?

Can't say I'm an expert (currently reading Gene Callahan's book, and then he turns up here!) but I don't think the Austrian view says anything about how smart people are (in contrast to the way Noah characterizes human action), just that they act purposefully to effect change on the basis of their own preferences.

I found this presentation on Ramon Marimon's web page. It is a discussion about Hayek's ideas. It seems that Lucas was going to give the talk but end up not going. So Ramon Marimon used some of the emails he had with Lucas in his presentation. You can find the presentation here

http://www.eui.eu/Personal/rmarimon/Ramon_on_Hayek_competition.pdf

And here are some examples of Lucas view on Hayek:

"Ramon,I am not going to be able to attend the Hayek conference.His paper is interesting to me, but I do have somereactions. I think the main problem with his paper stemsfrom his complete ignorance of general equilibriumtheory and game theory, even as these disciplines stoodin 1968. He is writing about something called“competition” without providing any decent definition orany awareness of how other people use this term. He iscriticizing views he thinks are misguided without citing asingle person or written work that exemplifies theseviews! (Lucas dixit)"

"I am not clear on what Hayek means by “macro‐” and“microeconomics.” By macro, he seems to meanthe use of national accounts. If so, I think he isconfused (as are most people) by contrasting“coarse” and “Fine” descriptions. Everything we dois “coarse!” Even “homogeneous” products likewheat or rice turn out to be complicatedcategories blurring many distinctions. What he isreally opposing, I think, is any kind of abstractmodeling and empirical work based on suchmodeling. (Lucas dixit)"

"In a Walras auction, participants know nothing buttheir own endowments and preferences and thewhole process is one of discovery. Everyone justlooks at the proposed price vector and says tohimself “if these prices prevail, what do I want todo?” I suppose it is implicit in Hayek’s essay thathe wants a more descriptively realistic deZinitionof competition than Walras provided, but what isit? (Lucas dixit)"

Some of the comments by Lucas are pretty silly. He must of read very little by Hayek. You could argue that Hayek was on the forefront of inter-temporal general equilibrium theorizing: his frigen dissertation - Hayek (1928) - was on inter temporal price equilibrium and the value of money. It's true he wasn't theorizing in math, so he was prone to missteps, but his approach was very much a general equilibrium one. In the Pure Theory of Capital he goes on and on about how important "dynamic equilibrium" is; and he's written an entire paper on more sophisticated notions of dynamic equilibrium with heterogenous expectations (see "Economics and Knowledge").

"Thus, if you were a smart young macroeconomist in 1980 who believed that people were both rational and smart, that government intervention was a bad idea, and that theory was the best way to investigate human behavior, you did not become an Austrian; you became a New Classical."

Actually although Friedman was a real thinker, the likes of Sargent, Lucas, Barro and Prescott are not. Basically we had the reverse here. They were applied mathematicians (who probably if they could would have worked in a Math Department) who basically fitted the classical paradigm and things like some of Ricardo's more ridiculous musings into the math. Ie the math was not fitted into the economics, rather, the economics was fitted into the math. There was enough in classical English PE and post WWII US economics for them to get started.

The view that people are rational, greedy etc was merely convenient.

These people are technicians. They are not people with profound views of the world and humanity, with big ideas, insights and solutions to the world's problems.

What do you actually *mean* when you say "econ was fitted to math"? Be precise. You're suggesting that when we translate economic ideas in ordinary language to formal language, something's lost. But that's not a problem with math, that's a problem with the translation.

And how is a researcher supposed to test the idea that "things have gone backwards since Friedman"? I imagine it's conveniently defined in a way that it only leads to your conclusion: math bad.

Blanket statements like these cause rifts where there shouldn't be any. Math has for centuries helped us clarify problems. Economics is no exception.

"Blanket statements like these cause rifts where there shouldn't be any. Math has for centuries helped us clarify problems. Economics is no exception."

Your point that a lot of the problem is bad maths rather than maths being bad is a reasonable one. However, it seems a lot of artificial construct has been put in place for the convenience of constructing formal models and the utilisation of mathematical devices. Think of things like the long run steady state. Do you think any, literally any, real historian would say there is such a thing?

Artificial construct and abstraction does not always clarify things, rather it adds unnecessary clutter and obscures things.

My understanding is that above all Friedman was an empiricist. He developed his ideas on the problems of variable money supply by looking at data and historical documentation. He did not start with a micro-founded model to get to that insight.

A lot of Macro now is about studying things like Markov Chains. Students are encouraged to study this, rather than go away and write a literary dissertation. I just worry that the techniques and the models are determining the analysis and therefore the findings and we are not going to get real insight that comes from going out on the field, observing, formulating your own explanation, and then comparing it with different theories that offer contrasting but plausible explanations and using them as reference points.

Basically formalisation could be leading to more empirically dubious artificial construct and abstraction, leading to less likelihood we are going to get new and good ideas on how to deal with third world poverty and youth unemployment.

Back in the 1980s, the Austrian school could all meet in a restaurant without having to book ahead.

If you name dropped Hayek in the 1980s and early 1990s, any sign of name recognition would have indicated that you were been interviewed by educated people.

The NYT ob says that ‘Mr. Hayek influenced virtually every prominent free-market economist, from Milton Friedman to George Stigler’! Hayek could not even get a job in the economics department at Chicago.

the NYT Obituary also says that “An ardent opponent of most Government intervention in the economy, he was all but ignored by other economists for 30 years after World War II, although he was respected for early contributions to monetary theory.”

Hayek’s son got a longer UK independent obituary than his father on the strength of his father's rebounding reputation.

The Austrian school now has sessions both at the southern economic association and American economic association. Peter Leeson was rated as one of the ten best young economists around.

Getting more to the point, the Austrian view deeply influenced the way people and especially macro fund managers today understand the credit and business cycles. That's much more than can be said of any modern mainstream macroeconomic school. Keynesian theory is only respected as theory explaining the down side of the cycle and how to react to it, with the exception of Minsky and his Austrian-influenced credit cycle theory. Neoclassical macro isn't really respected outside academia and doesn't really aim for anything but the bookshelves. New Classical lives only within a cloistered right-wing world.

That said, Austrian theory is 100 years old and you can't really expect it to be contemporary. It was conceived in an age when currency was gold-backed and manufacturing dominated GDP. It treats the very existence of broad money with suspicion. Contemporary doctrinaire Austrians who treat old von Mises and Hayek texts like scripture are boring and useless.

I just wanted to point out a piece of evidence supporting Noah's thesis: if I'm not mistaken, Kydland-Prescott's paper "Time To Build" actually cites Böhm-Bawerk's theory of capital, which is the foundation of Austrian business cycle theory.

Doesn't each school of economics have its own armchair microfoundations bedtime story? Surely Lord Keynes did his share of this. The New Classicals have their rational expectations omniscient agent who is merely in need of an economist to design a price signal for him. I don't see how von Mises was unique in the "mistrust of empirics" topspin you used.

Isn't malinvestment and financial market malfunction central to the Austrian business cycle concept? And kinda relevant to the recent credit crisis? Minsky didn't conceive of his moments as some random roll of the dice, but an increasing risk profile due to malinvestment.

What happened to Boss Noah that had Krugman whimpering "nihilism" a couple weeks ago? You were on a roll with Skippy the Flying Mongoose...

Noah, Bryan Caplan, whom I regard as a right-wing loony himself, has a piece online going into more technical detail on some of the points you made. It's called "Why I Am Not An Austrian Economist" and it's here:

I recall that somewhere Lucas explicitly stated that when he was developing his stuff he thought he was channeling and formalizing the Austrians... but then Kevin Hoover convinced him he wasn't, it was fundamentally different.

Ok wait ... ... ...

Here's something about it: http://econjwatch.org/file_download/742/LucasIPEL.pdfthough that's an article talking about it (in EJW of all places)

You can find on youtube a debate between Caplan & Boettke on Austrian economics, wherein the latter agrees (with Tabarrok, who raises the issue from the audience) that it was a terrible mistake for Austrians to hitch themselves to Clower & Leijonhufvud rather than Lucas.

Prescott does seem to be overly enamored of his theory in the face of evidence, but his "Measurement" paper is actually more sensible than the title indicates. He makes that point that observation is theory-laden, which measures we bother to collect and analyze are affected by what theories we have. As new theories suggest that new forms of data will be of interest, what we measure will change.

I refer you to the General Theory, Book III "The Propensity to Consume" for Keynes' armchair microfoundations bedtime story. It is comforting with a cookie and a glass of milk. It's true that he did not like the classical bedtime story.

The question I tried to pose was, "did Keynes have his own form of 'praxeology'?"--an a priori microfoundations theory or philosophy independent of "empirics". I would argue the answer is yes, and submit Book III as his "microfoundations of demand". In there, he sets up a priori principles about what motivates man's propensity to consume.

My original criticism was that if Noah lobs a "mistrustful of empirics" grenade at Austrians, he is going to hit the entire macroeconomics field with shrapnel. He should be more careful with that thing.

From my point of view, is amazing how in every blog that criticizes ABCT, the same pattern arises.

ABCT theory is not about "crappy" mal investments, but about non sostainable investments without credit expansion, that is completely different. Is not about that after a burst, people suddenly realize that certain goods and services are not good enough or are crappy. Its about mis allocation of resources, a productive structure distorsion. Interest rates manipulation provides the wrong signal to productive structure, the same that inflation to prices.

In Spain, when C and I started to grow, it was thanks to credit expansion coming from Germany and France. A entirely society started to invest in real state, so a huge construction industry started to grow also. After 10 years of over investment and over consumption, whats the result in my country? a huge over production structure distorsion, it means, a entirely house building society with overcapacity based on debt, and THAT's the key. The miss allocation refers to over investment in an industry that can not grow forever at this rates. Our entire society was driven by houses. Thousands of new enterprises started to be created (miss-allocated) like real state agencies, furnitures, plumbing, house accesories, air conditioning, interior design, thousands of new architect students finishing university ... the list is endless. Why miss-allocation? obvious: once the bubble popped, we had a huge extra capacity of everything. Millions of corporations and enterprises not based in productivity, but based on debt and cheap money. Once the debt machine stopped, all this companies bankrupted. Huge amounts or resources (capital) were driven to goods and services miss-allocated, invested in unsustainable projects that couldn't be profitable without a credit expansion. And now all this miss-allocated resources are destroyed, so have to be restored (saving again). The time-structure is really messed up. Capital used to build more houses than Germany, England and France at the same time, could be used for other stuff. And now, all this capital structure needs to me liquidated. Thats another KEY. A entire society needs to be reallocated. Not in good and services that people like or are less crappy, but in other stuff different than housing bubble. Stuff that would be profitable under 'normal' interest rates, and not based on debt and low productivity. We have lots of airports without passengers. Highways without cars. Overcapacity in energy production (oil, gas, etc.).

The key issue in here is not about that private sector allocates resources perfectly. The Austrian community do not advocate for perfect markets or perfect private sector resource allocation. Bubbles exist because are based on irrationality. There are not so many schools advocating for this. How come we say that private sector allocates perfectly when all this mess is the result of huge private debt (financial, non financial and households), and not because of public investment? The key issue in here is that if goverments and central banks could provide to society with REAL interest rates (not manipulated by central banks worldwide), proto bubbles would never become bubles. If in Spain in 2001 or 2002 real interest rate would had raised up, we wouldn't had continued investing in housing bubble until 2009, and we wouldn't had allocated all that capital (savings) in wrong investments. But interest rates didn't raise up. I repeat, wrong investment means not "crappy" good and services, but unsustainable projects that can not survive if the society is not living a credit expansion.

The key of all of this is that according to keynesians, the issue came because of an aggregate demand suddent stop, that do not recover because of sticky prices and wages. Suddenly, people stopped consuming. Its like the bubble never existed, just a future confidence sudden stop. So the FED has to enter to stabilize the short run, to keep the long term grouth thanks to economic and fiscal policy. Ok, i am not saying that it shouldn't be like this at all (i don't want people starving in streets), but you can't blame Austrians when they say that a time for re-allocation production structure has to happen (do you think Spain can continue building 1 million houses per year? according to economic mainstream, yes). Or that the society, as an aggregate, needs to increase _real_ savings (not consumption). Or FED will continue creating more bubbles because of the wrong incentives (lender of last resort, even if banks extend the risk to infinite). That interest rates manipulation for allocation, is the same than price manipulation for inflation.

You can not blame austrians for this advices. You can't blame the doctor for prescribing the consequences of bad habits. To me Austrians are the only economic school that explained to me what happend in my country, from the perspective of micro and macro level. How European Central Bank provided repos during a hole decade so German and French banks could expand the credit in the south or Europe, above all, in real state. And how this interest rate manipulation created a entire industry that was not sustainable after the bubble bursted. Is not about that houses suddenly became "crappy", or people stop desiring this goods.

Well no it not interest rate manipulation that is the issue, it is the single currency. (And the country as a whole savings more, means that it needs to run a trade surplus.) I don't deny that there were real estate bubbles in some countries (but all the badly hit countries - except the own goal in Holland were trade deficit countries). But there is no evidence that low interest rates are sufficient to cause housing bubbles (really land price bubbles).

"And now all this miss-allocated resources are destroyed, so have to be restored (saving again)."

This statement shows a great misunderstanding. First mis-allocated resoures don't get destroyed, it is money that gets destroyed in bankrupcy. Many of the resources can be sold and reused. Secondly, saving won't restore the resources, at best it just restores individuals financial stability - but if the whole society tries to save at once everyone will be poorer, because one man's cost is another man's income. You can't just extrapolate from an individual to an entire economy, it doesn't work like that.

But mathematical modeling is the bread and butter of New Classicals, and in fact is a "special mark of pride...So it basically seems to me that the New Classicals captured and improved on the basic ideas of the Austrians"

Have you ever considered a possibility that no mathematical model of the real world is perfect?Does it matter to you that the models used by the most highly esteemed economists (from MIT and Princeton for instance) over the past 15 years have been dead-wrong?

I really empathise with this comment. I think those of us who work in the humanities and social sciences outside economics cannot understand the economist's love affair with mathematics. Is something that can be expressed well in words (if someone is a good writer), can be understood to be people outside the discipline (psychologists, historians, Sinologists, sociologists, ... who you then can interact with and get their insights in return), and more than that is actually empirically well substantiated, and even better still can be used to solve the world's problems not better than something that expresses what can be put into words into a complicated format, is inaccessible except to a few, has to be based on controversial, even absurd, assumptions, wrong and basically useless?

"But mathematical modeling is the bread and butter of New Classicals, and in fact is a "special mark of pride"

Mathematical "rigour" should not be the yardstick of good theory or analysis. The priorities are all wrong. Clarity is desirable, sure, but ultimately it is whether it fits the facts. If it also solves a (real world) problem - and believe me we have quite a few - then it is a real winner.

financial markets and businesses' investment decisions are, in New Classical theories, functioning optimally at all times

John Cochrane, for one, recognizes that the financial crisis hit the shadow banking sector first and hardest. That the crisis was worst in the least regulated and most sophisticated part of the financial system has not shaken him in his belief that government regulation is bad and unnecessary.

The New Classicals really need to reconcile their world view with the melt down of shadow banking (and the collapses of AIG and LTCM). In their world none of those events could have happened the way they did.

[i]The only slight exception is the idea of malinvestment and financial market malfunction, which the New Classicals discarded entirely[/i]

I think this is a great post, but to me this seems like more than a "slight exception". I don't have nearly your breadth of knowledge of econ, but I also don't have any reason to worry about upsetting anyone in the sphere of econ, so I can say quite clearly that ignoring malinvestment as a potential cause of business cycles and instead insisting that business cycles are caused exclusively by shocks such as slowdowns in the rate of technological progress or increases in harmful government intervention is so silly as to make it hard to take "New Classical" thought seriously. It seems a school of thought for those who are highly educated but not very intelligent.

This reliance on external shocks is really the New Classicals saying: "Everything really interesting and important happens outside our theory and all we are studying is how the system responds to random impulses".

I want to highlight one point you mention in passing. I have a pet theory that a fair amount of intelligent peoples' natural left-right leanings derive from their natural preference for deductive vs. inductive reasoning. It seems that people who place relatively high value on logic and reason tend to be more conservative than those who place greater weight on observation and evidence.

Where do you get this from? Do you just make up whatever sounds controversial, or you have some other blog to copy from?

Rothbard was not Mises, Hayak was not Rothbard. If you want something modern try Peter G. Klein who has taken the theory in his own direction, very much building on the ideas that came before him, but not slavish to them.

You do know about "The Knowledge Problem" right? I mean, anyone who takes even a cursory glance at Austrian Economics would know about that. That's the bit where the Austrians explain the actual reason why central planning consistently fails. Not based on prejudice but based on theory (and successful theory that predicted the collapse of Communism in more than one country, as well as predicting the present day poverty of North Korea, and the coming collapse in Venezuela).

"The Knowledge Problem" is one of those Austrian ideas that feels true when you first read through it, and if you never bother to think critically about it, you'll probably go around the internet using it as an example of why central planning doesn't work. The only problem is that it's completely bunk. I always found it odd that people would charge central planning for ineffectiveness when the 2 prime examples of it, Russia and China, both took backwards feudal societies and turned them into industrial powerhouses inside of a single generation. It came at a huge toll in human suffering, for sure, but the resulting industrial expansion is indisputable. But more to your point, the Soviet Union did not collapse because of it's economy. There was a strong move for political liberalisation within the USSR that eventually overturned the old order and pushed the country into adopting a free market economy. But it's not like the USSR saw a 1930's style depression and was forced to abandon central planning. And China still produces half it's goods and employs half its work force under state owned enterprises with strong guidance from central planning. China's not going to collapse anytime soon.

Insofar as the best of it has been assimilated into mainstream economics, you might say that the Austrian school has been successful. On the other hand, with fewer professional economists identifying as one, the name of it seems to have become co-opted by people who care more about being in the out group, criticising the in group. On YouTube you will find many self-styled Austrians, each with a disturbing following. Google's tracking system is used to suggest similar channels and videos according to viewership. When you watch these "Austrian economists" you're always only one step away from some completely bonkers conspiracy theory stuff. It should disturb anyone who has affinity for the Austrian tradition that it's gravitating in the direction of some rather shady ideas. It doesn't bother me at all, and I'm vouchsafed in my original judgement of Austrianism given that it comports so well with formidable nonsense.